1/26/202

1 FINANCIAL ACCOUNTING AND ANALYSIS

BY
MR. ASHOK KUMAR

2 DEPRECIATION
• DEPRECIATION IS THE PERMANENT AND CONTINUING DECREASE IN THE QUALITY, QUANTITY OR
VALUE OF ASSET.

3 CAUSES OF DEPRECIATION
• WEAR AND TEAR IN ASSETS
• EXHAUSTION- AN ASSET MAY GET EXHAUSTED THROUGH WORKING. EX, COAL, OIL WELLS THEY
WILL GET EXHAUSTED AFTER SOME POINT OF TIME.
• OBSOLENCE- IT MEANS SOME ASSETS ARE REPLACE BY THE NEW MACHNE WHICH IS MORE
EFFICIENT THEN THE OLDER ONE.
• EFFLUX OF TIME- CERTAIN ASSETS GET DECREASED IN THEIR VALUE WITH THE PASSAGE OF TIME
• ACCIDENTS- AN ASSET MAY MEET WITH ACCIDENT AND IT WILL LOST ITS VALUE.

4 OBJECTIVES OF PROVIDING DEPRECIATION

• ASCERTAINMENT OF TRUE PROFIT
• PRESENTATION OF PROFIT- THE ASSET GET DEPRECIATED IN THEIR VALUE OVER THE PERIOD OF
TIME ON ACCOUNT OF VARIOUS FACTORS. IN ORDER TO PRESENT A TRUE STATE OF AFFAIR OF
BUSINESS, THE ASSET SHOULD BE SHOWN IN THE BALANCE SHEET, IN THEIR PROPER VALUE.
• REPLACEMENT OF ASSETS- ASSET USED IN THE BUSINESS NEED REPLACEMENT AFTER THE EXPIRY
OF THEIR SERVICE LIFE. BY PROVIDING DEPRECIATION A PART OF THE PROFITS OF THE BUSINESS
IS KEPT IN THE BUSINESS WHICH CAN BE USED FOR PURCHASE OF NEW ASSETS.

5 DEPRECIATION ON REPLACEMENT COST

• CHARGING DEPRECIATION ON REPLACEMENT COST HELPS THE COMPANY TO PROVIDE ENOUGH
FUNDS TO REPLACE THE OLD ASSETS IN THE COMPANY. IT WILL BE APPROPRIATE TO PROVIDE
DEPRECIATION ON THE REPLACEMENT COST OF THE ASSET RATHER THAN ON HISTORICAL COST.
IF DEPRECIATION IS CHARGED ON THE BASIS OF HISTORICAL COST THEN THERE WILL BE NO
ENOUGH FUND WILL BE AVAILABLE TO REPLACE THE ASSET DUE TO INFLATIONARY EFFECT.

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• FOLLOWING ARE THE DIFFICULTIES IN CHARGING DEPRECIATION ON THE REPLACEMENT COST.
1. IT IS DIFFICULT TO ESTIMATE THE REPLACEMENT COST OF THE ASSET IN ADVANCE.
2. THE NEW ASSET PURCHASED FOR REPLACING THE OLD ASSET IS ALWAYS OF A BETTER TYPE IN
RESPECT OF ITS QUALITY AS WELL AS EFFICIENCY. OF COURSE ONE HAS TO PAY MORE FOR THE
NEW AND UPGRADED ASSET WHICH WILL INCREASE BUSINESS PROFITABILITY. SO IN CASE
DEPRECIATION IS CHARGED ON REPLACEMENT COST, DEPRECIATION IS CHARGED FOR THE
IMPROVED ASSET EVEN WHEN SUCH ASSET HAS NOT BEEN USED IS VERY DIFFICULT.
3. INCOME TAX AUTHORITY DO NOT GIVE AUTHORITY TO CHARGING DEPRECIATION ON
REPLACEMENT COST.
4. BUSINESSMAN FAVOR CHARGING DEPRECIATION ONLY IN INFLATIONARY PERIOD BUT THEY
WILL NOT DO THE SAME WHEN PRICE ARE FALLING.
5. UNDER THE COMPANIES ACT BUSINESS CAN ONLY CHARGE DEPRECIATION ON ORIGINAL COST
OR THEY CAN CHARGE ON BOOK VALUE.
6.